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Call Start: 08:30

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FARO Technologies, Inc. (NASDAQ:FARO)

Q1 2013 Earnings Conference Call

May 1, 2013 08:30 AM ET

Executives

Vic Allgeier - IR, TTC Group

Jay Freeland - President and CEO

Keith Bair - SVP and CFO

Analysts

Chris Godby- Stephens

Mark Jordan - Noble Financial

Jim Ricchiuti - Needham and Company

Richard Eastman - Robert W. Baird

Patrick Newton - Stifel

Operator

Good morning, everyone, and welcome to the FARO Technologies Conference Call in conjunction with its First Quarter Earnings Release. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions). Please note today’s call is being recorded.

For opening remarks and introductions I will now turn the call over to Vic Allgeier. Please go ahead.

Vic Allgeier

Thank you and good morning, everyone. My name is Vic Allgeier of the TTC Group, FARO’s investor relations firm.

Yesterday after the market closed FARO released its first quarter results. By now you should have received a copy of the press release. If you have not received a copy of the press release please call Nancy Setteducati at 407-333-9911. Press release is also available on FARO’s website at www.faro.com.

Representing the company today are Jay Freeland, President and Chief Executive Officer; and Keith Bair, Senior Vice President and Chief Financial Officer. Keith and Jay will deliver prepared remarks first and will then be available for questions.

I would like to remind you that in order to help you understand the company and its results; management may make some forward-looking statements during the course of this call. These statements can be identified by words such as expect, will, believe, potential, continue, predict, target, growth targets, goals, guidance, and similar words. It is possible that the company’s actual results may differ materially from those projected in these forward-looking statements.

Important factors that may cause actual results to differ materially are the Risk Factors set forth in yesterday’s press release and in the company’s filings with the SEC.

I’ll now turn the call over to Keith.

Keith Bair

Thank you Vic and good morning everyone. Sales in first quarter of 2013 were $65.4 million, an increase of $0.2 million compared to $65.2 million in first quarter 2012. Product sales decreased by $1.9 million or 3.6% to $52.5 million for the three-month ended March 30, 2013 from $54.4 million for the first quarter of 2012 primarily as a result of lower average selling prices across all regions in response to competitive pricing pressure for the Company’s products.

Service revenue increased by $2.1 million or 19.3% to $12.9 million for the three month ended March 30, 2013 from $10.8 million in the same period during the prior year, primarily due to an increase in warranty revenue. On a regional basis, first quarter sales in 2013 in the Americas increased 4% to $26.1 million compared to 25.1 million in the first quarter of 2012.

Sales decreased 4.8% in Europe to $21.9 million in the first quarter of 2013 from 23 million in the first quarter of 2012. Sales in the Asia Pacific region increased 1.8% to $17.4 million for the first quarter of 2013 from $17.1 million in the first quarter of 2012.

The effect of changes in foreign exchange rate on sales was a decrease of 1 million in the first quarter of 2013 compared to the first quarter of 2012. New orders increased 4% in the first quarter of 2013 to approximately $64.4 million compared to approximately $62.1 million in the first quarter of 2012.

On a regional basis, first quarter orders in 2013 in the Americas increased 25.2% to $27.3 million compared to $21.8 million in the first quarter of 2012. Orders decreased 7.9% in Europe to $21 million in the first quarter of 2013 from $22.8 million in the first quarter of 2012.

Orders in the Asia Pacific region decreased 6.9% to $16.3 million in the first quarter of 2013 compared to $17.5 million in the year ago quarter. The top five customers by sales volume in the first quarter 2013 were VRSI, The U.S. Military, (inaudible), Science and Technology Facility Council and Toyota and together represented only 3.3% of sales.

The top ten customers in Q1 2013 together represented only 5.2% of our sales. Once again indicating our lack of dependence on anyone or handful of customers. Our gross margin was 56.3% in the first quarter 2013 compared to 57% in the year ago quarter.

On a quarter-over-quarter basis gross margin from product sales decreased to 59.3% in first quarter 2013 from 62.3% in the first quarter of 2012 as a result of lower average selling prices and an increase in the sales mix of laser scanner product sold to distributors. Gross margin from service revenues increased to 44.1% in first quarter of 2013 from 30.2% in the prior period due to increased warranty revenues.

Gross margin improved sequentially from 53.4% in Q4 2012 primarily due to lower manufacturing cost, improved product pricing and an increase in warranty revenues in the first quarter of 2013. Selling expenses were 25.5% of sales in the first quarter of 2013 compared to 24.6% in the year ago quarter.

Selling expense increased to $16.7 million in the first quarter of 2013 from $16 million in the first quarter of 2012 primarily as a result of increase in travel costs of $600,000 and an increase in compensation of $400,000 partially related to additional headcount offset by decrease in threshold expense of $300,000.

Administrative expenses in the first quarter of 2013 were 11.5% of sales compared to 10.2% of sales in the first quarter of 2012 increasing by $900,000 to $7.5 million in the first quarter of 2013 from 6.6 million in the prior year quarter. Increase in administrative expense is as result of an increase in compensation cost of $700,000 and bad debt expense of $200,000 offset by lower professional and legal fees of $200,000. Legal and professional fees related to patent litigation decreased by $100,000 to $200,000 in the first quarter of 2013. Research and development expenses increased to $5.1 million in the first quarter of 2013 or 7.8% of sales compared to $4.4 million or 6.8% of sales in the first quarter of 2012. R&D expenses increased primarily due to an increase in compensation and subcontractor’s expenses of $700,000.

Operating margin for the first quarter of 2013 decreased to 8.7% from 12.9% in the year ago quarter primarily as a result of an increase in operating expenses of $2.4 million or 8.2% to $31.1 million in the first quarter of 2013 from $28.7 million in the first quarter of 2012.

Other income and expenses net increased on expense on $100,000 for the three months ended March 30, 2013 compared to income of 200,000 in the three months ended March 31, 2012 and consisted primarily of net foreign currency transaction gains and losses resulting from changes in foreign exchange rates on the value of current intercompany account balances at the company subsidiaries denominated in different currencies and other expenses.

Income tax decreased to $1 million in the first quarter of 2013 from $1.9 million in the first quarter of 2012, primarily as a result of a decrease in pre-tax income. The effective tax rate decreased to 18.4% in the first quarter of 2013 compared to 22.1% in the first quarter of 2012 and included the reduction in the income tax rates of 1.4% and 5% respectively related to the tax benefit of the exercise of employee stock options. The effective tax rate for the first quarter of 2013 also includes the discrete tax benefit of 7.5% related to the retroactive legislation reinstatement on January 2, 2013 of the research and development tax credit for the year ended December 31,2012 which is required to be included in the period the reinstatement was enacted into law.

Net income decreased to $4.6 million or $0.27 per share in the first quarter of 2013 compared to $6.7 million or $0.39 per share in the first quarter of 2012.

I will now just briefly discuss a few balance sheet and cash flow items. Cash in short-term investments were $169.6 million at March 30, 2013 compared to $158.2 million at December 31, 2012. Accounts receivable was $53.7 million at March 30, 2013 compared to $62.6 million at December 31, 2012. Days sales outstanding at March 30, 2013 increased to 75 days from 71 days at December 31, 2012 primarily related to an increase in (GSOs) in Europe. Inventories increased to $68.3 million at March 30, 2013 from $68 million at December 31, 2012. The increase in inventories was primarily related to an increase in finished goods of $2.4 million offset by reductions in raw materials and service inventories.

I will finally conclude with some statistics regarding our headcount numbers. Globally, worldwide sales and marketing headcount increased by 60 or 17.8% to 398 at March 30, 2013 from 338 at March 31, 2012. Globally, account manager headcount at March 30, 2013 increased by 36 or 22% to 200 from 164 at March 31, 2012.

Regionally, account manager headcount increased by 14 or 26.9% to 66 at March 30, 2013 from 52 at March 30, 2012 in the Americas. Europe account manager headcount increased by 9 or 17.3% to 61 from 52 and Asia increased account managers by 13 or 21.7% to 73 from 60. We had 1,004 employees at March 30, 2013 compared to 911 at March 31, 2012; an increase of 93 employees or 10.2%.

Geographically, we now have 403 employees in the Americas, 339 employees in Europe and 262 employees in the Asia Pacific region. I will now hand the call over to Jay.

Jay Freeland

I am going to keep my comments relatively brief today, so we can get straight to the Q&A. But for starters, the highlight in the last May’s earnings release, we are seeing continued pressure in Europe and Asia from sluggish economies and intensified competition as the Directors alter the business climate.

While we are seeing some signs of strength in the Americas, as evidenced by a 25% orders growth in that region there was not enough growth to offset our performance in Europe and Asia. As a result overall growth suffered in the first quarter.

During our last earnings call, I stated that we believe the first half of this year will be difficult with a potential for improvement in the second half. And based on the current environment, we believe that’s still be the case. The business climate across Europe and parts of Asia remains weak. CapEx budgets of many customers continue to be frozen or slow moving and financing is difficult to arrange particularly in China and India.

Sales to new customers in the first quarter were 37%, also it were a reflection of the current economic environment. Strategically our goal is going to stay as close to a 50-50 split as possible. However, similar to previous periods of economic weakness, the first quarter ratio leaned more heavily towards exiting customers particularly in the metrology space where they already understand the ROI of FARO’s products and thus are more prepared to make the required capital expenditures.

The Focus Laser Scanner continues to be the only device of its kind in the market. Sell through rates are encouraging and consistent with our pattern over the last twelve months. Sales through distribution were 63% in Q1 down slightly from 66% in Q4 but up significantly compared with Q1 of last year.

And this comes from both the Trimble relationship as well as expanded access to the top finance global distribution network. We expect growth and the number of distributors to be slower over the next few quarters. But output from the distributors, we already have in place of expand, as they improved the around efficiency in selling the scanner.

We invested aggressively in new sales and research and development personnel on the first quarter. 60% of our head count increase came from account managers that we added around the world to expand territory coverage or add depth to the high potential existing territories. As always, we expect the new personnel to generate meaningful sales volume within six to nine months of their higher date. Disposition to the new account managers to start delivering on expectations in the second half of this year. R&D headcount expanded 11% in the first quarter. The additional talent is helping us to aggressively pursue multiple development programs. I also made a few R&D leadership changes in the first quarter replacing the engineering leader for the Arm, ScanArm and Gage product line and opening a search to find a new engineering leader for our metrology software platform.

The Arm leadership role was filled from within FARO but the software role comes from the outside increase in opportunity fresh ideas into the organization. The engineering teams for both groups remain firmly intact but I felt the leadership change needed to happen now as I continue transforming FARO.

With respect to the search for new managing Director in the Americas, but I can say that its proceeding well, there are several excellent candidates in the mix and I am all going to make my selection before the end of this quarter.

No doubt, this is a difficult business environment; as a company our goal is to succeed in any market. We are investing aggressively particularly in sales and R&D to ensure that we’re positioned to break through the economic difficulties and remain the market leader in our space.

At the same time, we are working every angle we can to keep the rest of our expenses tight. As always I would like to thank the FARO team for their hard work and dedication. Thank you for your attention and I will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will go first to Chris Godby with Stephens. Go ahead your line is open.

Chris Godby- Stephens

Can you talk a little bit about promotional activity in the effect it had on the quarter and then as the year goes on, how do you expect to utilize from our activity?

Jay Freeland

Yes, we certainly continued promotional activity in Q1, more so in Europe and Asia than in the Americas. The Americas markets’ definitely stronger right now and we expect that to continue to be relatively strong over the rest of the year. Our commercial activity was; we try to be as surgical about it as we print, if you actually look at gross margin, obviously we had some sequential improvement in gross margin from Q4 to Q1. Some of that was a little bit of improved pricing as we were more surgical about how we did the discounting.

We certainly had plenty of dialogue with the team to understand what accelerated discounting and make a significant difference in the overall sales volume in the market place. The general feedback is that no, it would not make a substantial difference if we continue to be surgical about it, if you feel that, that is the right approach to the market place. Obviously, in any opportunity we (followed), we needed to move further on price to maintain our share, to maintain our customers particularly at our strategic accounts, we certainly are going to do that. So yes there is definitely more pricing pressure in the environment right now, but it tends to be more selective on where we are seeing it.

Chris Godby- Stephens

Okay, thanks for the color. And then hopping over to the laser scanner product, can you give us some additional color on how the Trimble agreement performed in the quarter?

Jay Freeland

Yes, so, I think it performs; it still, what I would say is relatively in line with our expectations. As we expected they are strongest in the Americas and so we saw nice benefit in the Americas there. It’s certainly not the only driver of the 25% growth in orders on the Americas, but it is the relationship with the Americas is probably the best there and that’s because they have the most coverage there as well. Europe and Asia they have decent significant amount lower coverage, in terms of distributors in the market place. And so not surprisingly, I would say that one is off to a little bit of a slower start and that’s not necessarily unexpected from how we knew Trimble’s position in the marketplace. And quite frankly it is another reason as to why we have continued to increase our activity with Topcon who tends to be strongest in Asia, not quite as strong in Europe and very weak in the Americas. So it’s almost a direct, you know it’s almost a poor opposite of the covers and strength we see on the Trimble side.

Operator

And we will go next to Mark Jordan with Noble Financial. Go ahead, your line is open.

Mark Jordan - Noble Financial

Good morning Jay, questions related to R&D. You mentioned, I believe that you would subcontracted out about $700,000 of the $5.1 million; do you see that subcontract need continuing and so should we assume 5 plus million in R&D quarterly through the balance of the year.

Jay Freeland

Well I think, because of us, one is we have always subcontracted portions of our work where, not surprisingly we are still relatively small company. So we have specific one-off activities where it doesn’t make sense to maintain dedicated headcounts because we don’t have enough activity forum, those are the types of things that we subcontract out. The 700 was not all subcontract. There is also increased compensation; you have got severance in there from the changeover in the leadership. So had a few other things that are in the mix there as well.

On an ongoing basis, I would say that we still are at target for R&Ds, we are somewhere between 5% to 7% of sales. Obviously, we are at the high ends and that’s why we have brought that in Q1 at 7.8%. A little bit of that is reflection of the sales are obviously lower than we anticipated as a company and so we added the resources where we needed them specifically R&D projects that are under way to ensure delivery. We’ve got some coming this year, some coming next year and so the timing of that was almost independent of the current revenue profile.

Would we be at the high end of seven, slightly above or slightly below for the rest of the year? I think that’s a reasonable prospect. Obviously, as you get deeper into the year we would still expect to see, you know our normal sales pattern, so you get to the year even though we may be spending similar amounts on R&D from a dollar standpoint, the percentage would probably come down a bit just because of the normal sales profile.

Mark Jordan - Noble Financial

Second question, look at the Q, you’ve got a breakout of operating profit by segment and the Americas this year swung to a million dollar operating loss versus about a $0.5 million gain in the first quarter of last year. Was that swing, the cause of a mix shift that impacted gross margin, or was it more an increase in operating expenses that caused the lower profitability in the Americas this quarter?

Jay Freeland

It’s more in the operating expenses, primarily R&D; when you look at the other reasons, Europe has R&D, Asia doesn’t have any R&D. So what you are going to see is primarily increases and R&D occurs or affects the Americas profitability from the operating side. We're also going to see all the severance pay running through the Americas region since that's where those changes took place as well as that's where all the corporate overhead is as well.

Mark Jordan - Noble Financial

And the warranty revenue that you had that favorably impacted the services piece from a profit standpoint. Is that tied to renewals or new sales?

Jay Freeland

It's a little of both but I would say there's been an aggressive push on new sales, when you look at the reliability of the products, we've always had reliable products but as that reliability has improved even further, the sales teams have aggressively been pushing multi-year warranties in the marketplace, extended warranties or extended coverage, depending on that we called study different things in each region and they have a slightly different flavor to them. But generally speaking, they're all extended warranties in terms of how we would think of it. And, I think that the customers though, you'll always have a significant portion of customers who are not interested in that. There are customers who see the value there and if they see it, if you see a decent deal on the warranty of the FARO equipment, we've had customers who've said, yeah you know what, I like that, it keeps the equipment up to date, it keeps it certified, you know the things that are important to them, in some cases it's about traceability within their own facilities. And the team has been fairly successful in pushing that a little bit in Q4, definitely showed up more in Q1 obviously.

Mark Jordan - Noble Financial

Should we assume that, that profitability of those margins should be the low 40% range versus I guess historically, we would have viewed it in the low 30s moving forward.

Keith Bair

Yes, I think we've moved up from Q4, approximately 34%, now we're 44%, a lot of it depends on the mix of what you're actually servicing in that quarter, some customers that actually don't have warranties and are kind of paying by the drink versus those that do. So you get a little bit of the mix difference there but I think we're targeting probably close to that 40% give or take for the gross margin going forward.

Operator

We go next to Jim Ricchiuti with Needham and Company, go ahead, your line's open.

Jim Ricchiuti - Needham and Company

Listening to some of the commentary, the need to raise R&D spending, increase headcount, for sales and marketing and just some of the price competition, it sounds as if there may be some share shift going on, do you feel you're losing some share in the market at this point.

Jay Freeland

I don't think we're losing what I'd call any type of significant share in the market place for sure, I think you've got the products themselves, there's some differentiation between the products for some product lines and obviously for others it gets a little bit closer in terms of the differentiation of the product. For us, there's a couple of things, one is on the sales side, which is recognition that we still have significant portions of territory that are in fact either uncovered, that's a little bit less of a case, you have a new country, things like that.

More so you’ve got, what appear to be, and historically have been, fairly fruitful territories where we looked at it and said, like there's a constraint still of how many demos a month an account manager can do. And there's way more lead activity coming in for that territory than that account manager can possibly handle. And that's obviously a good indication to split the territory and though we haven’t seen the fore sales benefit from that yet, for sure, given the environment. When the environment improves even a little bit and when you have that team fully up to (speed) kind of about six to nine month curve, we would expect to see improvement in the output at that point.

The R&D side quite frankly is a little more strategic in terms of what we're doing there. We have obviously a core set of products that we're working on. We have next generation in the works for all of them and they're at various stages and we've also seen the opportunity to both improve sort of the time cycle on those as well as there are couple of newer things that the team's working on that come out as a (inaudible) process that though I wouldn’t say those are near term expectations for the team. Those are products that are coming down the pipe as well, so there's this recognition that we reached a point that we need to start adding some additional resource to help support that as well.

Jim Ricchiuti - Needham and Company

Jay, earlier in the year you had alluded to the possibility of maybe looking at an acquisition or acquisitions just to maybe move into some other areas in the market. Where does that stand as the environment’s changing to the point where you are a little bit more cautious on moving forward?

Jay Freeland

No, I would say that we are still very interested in moving forward. There are several companies out there that are of extreme interest. And without saying where we would be in dialogue with any company for sure, the procedure of acquisitions is something that is of high interest, and the current market environment does not change that.

Because the types of the acquisitions that we look at, give the opportunity to expand the portfolio, expand the complete offerings of the customer base, allow us to more aggressively penetrate the verticals that we tend to be best in and give us the opportunity to have a complete sweeter products for those customers. So that side has not changed at all from a strategic standpoint.

Jim Ricchiuti - Needham and Company

Okay and just a final question, if we look at the way you are entering the quarter, it seemed like you had a little bit more momentum coming out of Q4. So how quickly did the environment change? And seasonally, this is a weaker quarter. So what are you seeing late in the quarter in terms of the activity?

Jay Freeland

Yes and that’s probably the right way to look at it. So the seasonal shift that we normally see when you look like say January and February was not all that different from what we’ve seen in the past. We are feeling a little more pressure but not to the point where we said oh my goodness, this is looking like a flat quarter. We are looking at a decent growth quarter even as late as February. Shifts in March, I think, we started to see and there is demand shifts for sure around the world. If you have just to use one customer being Daimler who is now, you know, so to talk about this openly, has seen a fairly decent fall off in demands particularly when it comes to markets like China.

And so they have shifted their expectations for the year, they have gone into, any time customers do that, one of the things they frequently do is they will look at all their cap expenditure or operating expenditures in the whole back on some of the programs. So you will see, I don’t want to cheer it for just Daimler because they are just a small customer amongst all the different customers we sell to, but it was that type of environmental shift that we started seeing in March.

The financing environment which is very important for places like India and China for not just FARO, I think for a lot of customers that many of our (inaudible) companies but a lot of our customers are buying on credit in those markets and that appeared to get merely tight. China was already tight for the last couple of quarters. By the last three to four, China has been so-so on the financing side. But India started getting really tight in the final sort of five or six weeks of the quarter, which was a bit of surprise in that environment. So that was a bit of the driver to it.

So a lot of this that we saw it was in the final five to six weeks of the quarter. It’s definitely more pressure than what we expected when we were coming into the quarter. Though we expected that the first half is still be sort of sluggish in general, I would say that the last four to five, six or the quarter definitely where harder than expected, even though we had lower expectations coming in.

Operator

And we will go next to Patrick Newton with Stifel. Go ahead, your line is open.

Patrick Newton - Stifel Nicolaus & Co

I guess just that done telling also that last three to four week has been a little bit harder than anticipated, would it be fair to say, you know it’d be realistic that the June sequential uptake or normal seasonal uptake, would be a little bit more medium this year?

Jay Freeland

Yes, I mean obviously we can’t say definitively, later on someone says okay there were some bright spots on America’s orders, they get growth rate in the first quarter and I would say that that growth rate was kind of in line with our stretch expectations, but there was stretch for sure. I think 25% orders growth in the first quarter. No doubt the first half feels, the total first half feels sluggish, so might the second quarter not be as, if you look at the sequential uptake we normally see, might there be more pressure on that in 2013 and we have seen in the last couple of years? Probably.

Could I put a finger on what this feels, I guess, flat with Q1, up from Q1, I can’t gave a flavor for that either at this point, I mean, the thing is both difficult and frustrating for the team in the field is that the leads coming in are really good, the number of demos that the team is doing also very good, there is plenty of interest out there and that leaves to them, is the customer is going to pull the trigger or not, so similar to when we have seen previous downtimes. It’s not just a drop off in the demand for the product. It tends to be more focused on customer execute this quarter, do they need to delay? There tends to be the harder side of the equation.

So, yes I would say, we definitely feel more pressure still or continued pressure I guess, I won’t say more but continued pressure in Q2, the second half of the year, harder to project though it does seem like at least the sentiment would appear that customers are going to feel more inclined by in the second half of the year. Obviously that, we all know, can shift relatively quickly.

Patrick Newton - Stifel Nicolaus & Co

Okay and then I guess just sticking on kind of the near term outlook, Keith could you help us understand, I think you gave the metric of gross margin on product basis was 59.3 versus 62.3. So, with that 300 basis point delta, can you help us understand, what was the FOS impact relative to an ASP impact?

Keith Bair

Yes. Typically, we don’t provide that level of detail but I think, as you know throughout 2012, we’ve continue to run for almost throughout 2012, started in the first quarter and continued through the fourth quarter. I think what you’re seeing though on the sequential basis, looking at Q4 of ’12 versus Q1 of ’13 is that, I think prices on some of the products have firmed up a little bit, but not all the products.

And I think we’ve seen some reductions in our manufacturing costs in the first quarter of 2013, but we’ve also seen when you’re looking at the Laser Scanner product, the huge increase in the sales through the distribution channel from 37% in the first quarter of ’12, to like 65% or so, 63% in the first quarter of 2013, that’s quite an impact to the margin.

So, I think I’ll just leave it with that.

Patrick Newton - Stifel Nicolaus & Co

So I guess the net is as you get your manufacturing cost down and now we’re getting distribution steadily at 60% and perhaps higher as you continue to ramp Focus Laser Scanner. Are the 53% margin days behind us? And we’re looking, I’m not saying that March levels are sustainable, but are we looking more to 55 on a go forward basis?

Keith Bair

Yes. I think roughly 55, 56 I think that’s probably the range. I think the 53% days of the heavy promotional discounting could be behind us.

Patrick Newton - Stifel Nicolaus & Co

Perfect. And Jay, you mentioned access to talk on the global distribution network, I was wondering if you can expand on that and I understand you don’t have OEM relationship like you do with Trimble. But, I’m wondering do you have access to their entire network at this point, or are you targeting kind of piece by piece the way did with Trimble before the OEM relationship.

Jay Freeland

I won’t say we have access to the entire network yet for sure, but I would say we’ve got a significant increase in access to their distribution network. Some of which has come with high level discussions within Topcon versus given on a distributor-by-distributor basis. We do not have an OEM relationship, you’re correct about that and our intend is not to try and do the same private label of the current Focus Laser Scanner in any way, shape or form. We would like to, and they seem to be very open to working as (FAROgrand) and moving out through their channel and as long as there is a good partnership in that regard and I think that, that works for them as well.

So, you’re right, this is not OEM; it is exciting from the standpoint that they do have a good number of distributors around the world. And I guess I've said before they are strongest in Asia and sort of midpoint in Europe and relatively low coverage in the Americas and that’s almost the opposite of how Trimble’s coverage rolls out.

Patrick Newton - Stifel Nicolaus & Co

And so is it fair to say that the benefit of that relationship go forthcoming?

Jay Freeland

Yes, I think so. No doubt we’ve been working with Topcon for a while, so it’s now like this is all brand new to us. But as we’ve added more here in Q4 and Q1, then yes, I would say there is always a learning curve with the distributor and how long it takes for them to get affected by the product as well. So it’s certainly worth anticipating. Quite frankly no, we certainly anticipate Trimble and that relationship continues to improve the output of their distributors improve as well they get more comfortable with the product.

Patrick Newton - Stifel Nicolaus & Co

Okay. And then just last for me is on the Trimble side. I think you talked about being fairly highly penetrated into their distribution channel exiting 4Q, but there is still a chunk. I don’t want to put words in your mouth but I think it was roughly 20% that was still had not started the ordering and that relationship. Are you now 100% penetrated or we through that stocking phase or now on the sell through basis for Trimble on a go forward?

Jay Freeland

Since you don't want to put words in my mouth I don't know if I’ll say it was 20% that we were uncovered with before. There is a piece that we didn’t have penetration with yet. I think we’re probably there. When I think about the Trimble relationship, there are some onesies, twosies that either we hadn’t signed up yet or hadn’t gotten into the boat yet, possibly if there is change at Trimble distributors that they make obviously.

That’s not something we control and so that we’ve made out some continuous flow in that regard. But we are at a point where I’d say yes I’m looking more for expanding productivity out of the distributors that are in place now versus growth coming from toeing up the one that were new to the product or new to the relationship.

Operator

(Operator Instructions). We will go next to the side of Richard Eastman with Robert W. Baird. Go ahead, your line is open.

Richard Eastman - Robert W. Baird

Just a question on the Americas, there is 25% order rate, could you do a couple of things and maybe just parch that out to you know, core business versus Trimble? Was the core business up in terms of orders double digit? Number one, and number two, where is that strength actually coming from, you know, exclusive of Trimble, which customer base is seeing that kind of delivery and that kind of order growth?

Jay Freeland

I’ll go in reverse order. When you look at the customer base, no doubt auto, aero, heavy manufacturing have all been pretty good actually in the Americas for FARO and I think you see that in general in the marketplace. So they have been a fairly good force here in the first quarter. Aerospace as you know has been actually pretty good for us around the world and fairly consistently for multiple quarters now, as that industry has certainly even with hiccups that Boeing has had along the way here with the Dreamliner, it has not had any type of meaningful impact on the business that continues to be a good customer. So when you look at big three, certainly those are the big three, and the Americas probably not surprise in that regard.

Core versus Trimble I guess what I say is that there is growth in the core for sure; there is growth in Trimble also. So parse it out and say it’s one double digit one single digit or they both double digit, I’d say they both growing well I would like to see both grow more aggressively than the 25% even. Given the current environment that may sound implausible for lack of a better word, but I think there is opportunity and when you look at where the growth comes from, it’s not just people have asked in the past because Brazil now direct and you’ve got huge opportunities there and you’re growing there.

Yes Brazil is a good market but I would say that United States is a largest market still by far and has been pretty good, so I can’t say that it just because of emerging markets that we're going to enter, the U.S. markets actually been fairly strong here the last three or four months.

Richard Eastman - Robert W. Baird

Okay and then with the Focus Laser Scanner, can you just give us sense of growth there direct versus distribution?

Jay Freeland

I think rate is relatively similar if you look at the amount of scanner that went through distribution in the first quarter of last year globally was 37% and in the first quarter the amount that went through distribution was at 63%. I don’t think we parched it region by region before but I would say that those uptakes are relatively consistent. The Americas maybe a teeny bit ahead of the curse only because we had more distributors signed up in the Americas at a more rapid pace.

Richard Eastman - Robert W. Baird

So the fact that obviously the inverse of the distribution split with direct, we still were up with the direct sales?

Jay Freeland

I don’t know how get into the specifics but we have to talk with our director of distribution. The direct sales force continues to be very effective and part of the exercise is then focusing them on other markets, and they do not go call on surveying and civil engineering now which is Trimble and Topcon, we’re very focused on the distributors there spending their time on that. So our team is getting into the manufacturers, the architects, the forensics side, the historical preservation side, they’ll be spending a lot of their time there to help develop those markets and thread the needle for future growth.

Richard Eastman - Robert W. Baird

And then maybe just; should we be a little bit surprised that maybe you got off to start such an aggressive start to the year with the growth investments, sales are indeed relative to the tone of top line sales. It just feels like; your operating expense ratios are exposed to you because sales were light, but I am a little surprised that you got off to that quicker start with the growth investments rather than kind of matching them to this tone of business.

Jay Freeland

Yes, perhaps a little bit. Like I said, FARO's are so pattern; the first two months of the quarter are usually relative slow and then the third month picks up substantially and through the first two months, things are still pretty good. I said not; when we look at our internal expectations, we knew is a little but short of that but all the data said 'hey this is still, potentially a fairly great growth quarter for us.

If you look at the headcount increases sequentially they are not nearly as extreme as the headcount increases quarter-over-quarter for sure. So, in some respect if you look at that way and so wasn't like we suddenly added 30% to the headcount sequentially though it is up significantly over Q over Q; a chunk of that was all added in the second, third and fourth quarter of last year. I think the investments were necessary and I would not have wanted to rate the R&D side for sure and the sales side was more looking at; there is clear markets where the amount of lead activity coming in could not possibly be covered by the account managers in place, and for sure there is always a debate on how long to you wait, do you pause, do you not go ahead and get a little bit ahead of the curve and we try not to get too far ahead of the curve here.

I think as we added them, they certainly felt in-lined with where we saw the quarter coming in no doubt, the quarter did not come in at the tail end as strongly as you would have liked, but I do think it does help position the company then for, you get a little bit of impact from it at best in second quarter. It’s more about Q3 and Q4. And (inaudible) that’s when they will become much more productive and enclosure to the normal output that we see from our experienced account masters.

Richard Eastman - Robert W. Baird

Okay and then just a question; maybe this is for Keith; but you are the P&L, when you look at the gross profit margin on products, for some reason historically it tends to be high in the first quarter and fade through the year. I don't know why; I mean is it something to do with your gruels or whatever that is. But the suggestion being that, almost 59% here in the first quarter; then maybe that drills down to the 55, 56% range for the year; you said is there any reason to assume that pattern won't continue this year?

Keith Bair

I think there are a couple of things; last year drill down I think because we sort of intensified our sales promotion from Q1 through Q4. So the sales promotion activity increased throughout 2012 and as a result of the increase in the distribution mix of Laser Scanner product that also has an impact on that product risk margin. I mentioned earlier that we are starting to see little firmer prices on us on a sequential basis on Q4 2012 on some of the product lines.

So I won't expect that things sort of quarter-over-quarter sequential decline throughout 2013 that you saw throughout 2012.

Richard Eastman - Robert W. Baird

Okay and last question and just for Jay when you talked about changing out some leadership on the R&D side, you specifically mentioned that you changed off the software leader key designer. Is there any secular shifts in your business towards; thinking about the value proposition of your tools towards the software component from the hardware piece.

Jay Freeland

The software piece is always an important element for sure. And that will not go away and your, alright look, software is the piece that people interface with, in some respects more sales than even the device. You're holding your arm in your hand and you are taking those measurements and a lot of the interface when the customer comes on the software side. So does that increase overtime? I think for sure, though I think it’s a substantial increase where you are saying, my goodness, the software suddenly is far more important than the device itself I think that’s less of a concern. The bigger focus is more about just what’s the entire ecosystem of products that you have than can solve the problems that the customer is looking for and no matter how big the software is some way, somehow you have to have efficient and accurate and repeatable and reliable hardware to capture all of that data and I think they go hand in glove with each other for sure, but you certainly say one by itself standalone is more important than the other.

So the change in both cases was more about wanting different type of leadership. It was not unlike the thought process I went through as I was changing our European Managing Director last year and the Americas Managing Director at the start of this year. A different focus for the company, a more aggressive push to the company, and look, different ideas bring different results and if done the right way it certainly brings fresh life and improvement things now where there is more that.

Richard Eastman - Robert W. Baird

A couple of your software partners have been acquired fairly recently and I just, is there a void in independent kind of software partners to take your products kind of to the next step in terms of processing power and 3D capabilities?

Jay Freeland

I would say no. The two who were acquired are both available to us and we continue to work them today we have very good relationship with 3D Systems and continue to have very good relationships with both of those partners. There is another independent who’s arguably the, kind of the largest out of the group that we still have a very close relationship with and work with. That being said obviously, particularly the more point clarity you are handling so you think about scanned data whether it is from a ScanArm or from a Laser Scanner.

The ability to handle that data easily simply with minimal training and so forth, is still sort of an open problem that nobody has resolved efficiently yet and that I think regardless of software partners or what you do internally is something that continues to have, there is a real need for that and quite frankly even some of the CAD companies are working in that regard as well. Because we all recognize that there is this seamless threat between what is captured and how it is used in CAD or how it is used for analysis on the floor from an SPC standpoint.

So those are all things that are important but I would say there is not, we certainly are not at a point where there is a lack of independent partners who will also be working with that regard.

Operator

And we have a follow up from Jim Ricchiuti with Needham & Company. Go ahead, your line is open.

Jim Ricchiuti - Needham & Company

Keith is there anything you can help us with in terms of G&A your G&A expense was up a fair amount sequentially as well as year over year. How should we be thinking about G&A for the year as a whole?

Keith Bair

Well, there is some compensation increased here but some of that was related to severance as well and I think we talked about it, I know we filed an 8-K with regards to that. Going forward I think the biggest variable in our administrative expenses has always, has been recently the patent litigation and I think to the extent that that continues or as a result fairly quickly that should be the only large variable for the administrative expenses going forward.

Jay Freeland

Yes I would say not surprisingly when you look at headcount increases; number one, I think the increases that we have made were definitely more front-end loaded. So you would start to see that slow a bit in the next three quarters anyway. Number two, admin is always the lowest on the pecking order that it takes an awful lot of convincing to get a new administrative head at it versus an Account Manager or somebody from R&D.

We got a little bit increase in the class to sales side they have support of service and slight amount to support production volume, but even that is a much lower priority and certainly a much lower growth rate than the other two being the Sales and Marketing on the R&D side. Generally speaking the actual headcount has been slow the rate slows for sure if you look at Q2, Q3 and Q4.

Jim Ricchiuti - Needham & Company

And just coming to the product discussion, how would you characterize the demand for the Laser Tracker, the new Laser Tracker in the quarter just in light of some of the weakness you saw across the business lines?

Jay Freeland

Yes the tracker demand is actually still being good as you know this was now the third full quarter, I guess not quite full when they first launched it, that’s the third quarter we had the product in the market place. It continues to be received very well by customers. The higher end tracker market is a little bit more of a specific niche than say our market or the scanner market and even potentially the scanner market that the laser scanner market is much newer. But I still feel good about the tracker. The performance were exact and that being said it also is not immune to the push from an R&D standpoint for what the next generation needs to look like and being as aggressive as we can and trying to accelerate what that next generation looks like.

Richard Eastman - Robert W. Baird

And just a final question, has the weakness in the Yen impacted you just from a competitive standpoint, or is the, I am just thinking of your Japanese competitor now.

Jay Freeland

I think in Japan it’s less about the Yen. I will say that in the first quarter, for the first time in a while there was more price pressure than usual, in Japan specifically. Now, you have to take it with a grain of salt because Japan historically is buying product at higher than this price in many cases. So price pressure there, it’s not the same as price pressure you might get, say in China or the price pressure we might see in India, or the price pressure we even see sometimes in occasionally United States, the customers just think differently about it. But in Japan, specifically it was a little bit more about just overall customer demand for lower price which is an unusual thing in that business environment and probably not a long term issue. I think it tended to be more tied to just the current economic climate there. We have seen it a couple of times in the past. I saw it couple of time in the past at GE where they were always buying at higher price. You occasionally hit these pockets where they put little more pressure on the price and then the pocket dissipates within a couple of quarters.

Operator

And we have one more follow up from Patrick Newton with Stifel; go ahead, your line is open.

Patrick Newton - Stifel

A couple more, one is you previously gave some distributor metrics where the percentage of distributors that re-ordered two times or more in the last twelve months, I was wondering if you have that metric for 1Q?

Jay Freeland

We did, I think it’s certainly still more than 50%, where re-ordered at least twice. The difficulty is as we transitioned to Trimble, you got two different things, one is you have some newer distributors in there, the other is that much of the volume is going through Trimble first then out to the distributor second; so it throws off the metric a little bit also in terms of where that distribution of assets is going. So I'm not sure the comparison we had in the past is even perfect anymore relative to just how the relationship of Trimble changed in the fourth quarter when we're on direct OEM with them.

Generally speaking, look at the independence, I am pretty comfortable with the re-order rates there, they are all in that pocket of at least twice in the last 12 months. What I like more, the other question has always been; what’s the right ratio? And I look at and say; well, hey the right ratio for me is every week. We're certainly not at that pace with any of them. You know, should it be back once a quarter, should it be back once every other month, summer special, I think it depends on the size of the distributor and their overall financial means and probably depend somewhat on the depth of the market they serve. There is no doubt that some of them are in lighter markets, and some of them are in more densely populated markets.

Patrick Newton - Stifel

Okay, that’s helpful. Then I guess the last one is just, on the ASP pricing pressure. I'm assuming it’s not as prevalent with the Focus Laser Scanner given the lack of material competition, you just made a comment that the laser tracker demand is actually still quite good. Is it fair to say that the most exacerbated pricing pressure is on the Arm?

Jay Freeland

Absolutely

Patrick Newton - Stifel

I asked a similar question about two quarters ago, when Hexagon had refreshed its product line up and asked if it's competitive or if it's macro. And I think at that time you said, without a doubt it's macro. It feels like now you’re saying it could be, it’s both. Is that fair?

Jay Freeland

Yes, I think it to be fair it’s a little bit of both. The macro is a big issue for sure and I think macro then causes you, it causes a customer to be more diligent, I guess looking at all of the available options now, all in this market is still to for the most part, you’ve got one small Arm competitor in Japan which is less the issue in Japan than it is just the price pressure I guess. But yes, so does the macro drive the customer to look at the products little bit more closely? Yes I think there is some of that for sure. Will that continue for the next few quarters? Certainly, I think it continues in Q2. Does it continue more in Q3 and Q4? Maybe, just maybe not as aggressively if the environment improves a little bit.

Patrick Newton - Stifel

And is the Arm still your number one product line?

Jay Freeland

It is.

Operator

There are no additional questions.

Jay Freeland

Very good, thanks everybody. I look forward to seeing many of you at the conferences here in the next couple of weeks, and update you again after Q2.

Operator

This does conclude today’s conference, you may disconnect at any time.

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